After the collapse of stock prices ending the decade-long bull market, stocks have come back about half way. However, the economy is looking worse. We asked recently why is the stock market ignoring the economy. How investors position themselves these days will be based on the answer to this question. What shape will the economic recovery be? There are three possible answers to this multiple choice quiz.
- V-shaped recovery
- U-shaped recovery
- L-shaped recovery
The V shape is what happened a decade ago when the financial crisis came on quickly and began to recover quickly. This is what investors hope for as they can jump in at the bottom and expect to see handsome profits.
A U shape is what happened with the Great Depression when the economy collapsed and did not really recover for a decade. In this case, investors can pick up bargains but will need to wait a long time to see their investments pay off.
An L shape assumes that there will be no recovery to previous levels. This is what economists and many investors fear the most.
What Shape Will the Economic Recovery Be?
Forbes speculates on this subject in a recent article, What Is the Shape of Economic Recovery, V, U, or L? They note that each category may have some businesses even though the overall economy may fall into one of the three options. To know which will apply, they say that three questions need to be answered.
- Have customer habits changed permanently?
- Did power dynamics structure in the value chain get completely altered?
- Did regulatory stance change?
Answer these questions and you will know if you need to find safe investments for a ten year recession or if you should go “all in” in expectations of a miracle recovery later this year. Forbes points out Royal Caribbean as a company that may be hurt for the long term by this crisis and Warren Buffett obviously thinks the same about airlines as he recently dumped all of his airline holdings.
Investing in Stocks Based on Which Shape Their Recovery Will Be
Investing in stocks for the long term requires an accurate assessment of intrinsic stock value. Smart long term investors only invest in companies for which they understand how the company makes its money and are certain that their business plan will work into the long term future. Consumer product companies always hold up well in a recession because they sell things that people need during good times and bad. Today we can expect companies that deal online to do better than their competitors as the coronavirus forces us to socially isolate. How will these business models do if the recovery is an L shape and never really comes back to its former level?
For more thoughts on this subject, take a look at what Market Watch says in their article about an abnormal economic recovery. They note that V shape is what happens when consumer stocks and financials get better first. Now it is the tech stocks and pharmaceuticals which are benefiting due to their being well-positioned in a situation driven by the virus. They view this as an indication that the recovery will be slow as with a U shape of incomplete as with the L shape.